New report notes ‘over-equalizing’ nature of equalization program

Over the past 15 years, the gap in economic well-being between Canada’s richest and poorest provinces has shrunk dramatically. In other words, Canada’s provinces are much more economically equal today than they were back then.

Unfortunately, the causes of this economic convergence do not constitute a good news story. Canada’s richest provinces have experienced severe economic pain over the past 15 years, which has hurt their ability to raise revenue. The growing parity is not due to strong performance in poorer provinces but rather recession and stagnation in richer ones.

Given these economic developments, you probably assume that Canada’s equalization program would shrink. After all, the program exists precisely to equalize the ability of each province to raise their own revenues to fund provincial government programs. If the gap between rich and poor provinces is shrinking, equalization payments should shrink as well.

Right?

Wrong. Instead, equalization payments continue to increase year after year. Why? Because a counter-intuitive rule introduced in 2009 requires overall equalization payments to increase in line with recent nominal GDP growth, no matter how much the gap between rich and poor provinces shrink. In recent years, this rule has meant bigger payments to recipient (or “have not”) provinces than would have been made without the rule.

And new projections from the federal Parliamentary Budget Officer’s (PBO) annual fiscal sustainability report suggest this state of affairs may continue for the foreseeable future. The report, which describes the “over-equalizing” additional payments made due to the 2009 rule, projects this over-equalization will persist until 2069.

Specifically, the report says that “Equalization transfers will exceed the fiscal requirements to bring all provinces up to a national standard through 2069, thus ‘over-equalizing’ by an average of 0.1 per cent of GDP.”

That may seem small at a glance, but many statistics appear small when compared to the entire annual production of the Canadian economy (which is what GDP measures).

For instance, a 0.1 per cent overpayment represents $2.3 billion extra equalization dollars going to recipient provinces this year that would not be paid in the absence of the rule. If the PBO’s forecasts prove correct, the cumulative total of overpayments in the decade ahead would therefore be substantial.

With an equalization referendum in Alberta looming in the fall, the Trudeau government should help defuse regional tensions by reforming the equalization program to remove the sources of legitimate grievances in “have” provinces such as Alberta, including the rule requiring payments to keep growing no matter how much “have” provinces are struggling.

Reforming equalization so it’s more in line with economic intuition—with payments growing if the economic gap between provinces grows and shrinking if it shrinks—could therefore kill two birds with one stone. It could help make the program more rational and fair while helping also address concerns about the program’s fairness by addressing a legitimate complaint about how the equalization works.